Q4 2023 UMB Financial Corp Earnings Call

Participants

Kay Gregory; Investor Relations; UMB Financial Corp

Mariner Kempre; Chairman, President & CEO; UMB Financial Corp

Ram Shankar; Chief Financial Officer, Executive Vice President; UMB Financial Corp

Nathan Race; Analyst; Piper Sandler & Co.

Presentation

Operator

Hello all, and welcome to UMB Financial's Fourth Quarter and Full Year 2023 financial results call. My name is Lydia, and I will be your operator. (Operator Instructions) I'll now hand you over to Kay Gregory with Investor Relations to begin today's call.

Kay Gregory

Good morning, and welcome to our fourth quarter 2023 call. Mariner Kemper, President and CEO, and Rob Schaefer, our CFO, will share a few comments about our results. Jim Ryan, CEO of UMB Bank, and Tom Terry, Chief Credit Officer, will also be available for the question and answer session. Today's presentation contains forward-looking statements, which are subject to assumptions, risks and uncertainties. These risks are included in our SEC filings and are summarized on slide 45 of our presentation. Actual results may differ from those set forth in forward-looking statements, which speak only as of today. We undertake no obligation to update them, except to the extent required by securities laws. All earnings per share metrics discussed on this call are on a diluted share basis and unless otherwise indicated, comparisons are versus third quarter 2023 net operating income discussed here and in our slides excludes the FDIC special assessment and certain other expenses and is reconciled in our press release and slide deck. Presentation materials are available online at investorrelations dot UMB.com. Now I'll turn the call over to Mariner Kemper.

Mariner Kempre

Thank you, Kay, and good morning. Before I get started, I'm going to talk about some very important business, both congratulating her hometown heroes, the Kansas City Chiefs for yet again headed to the Super Bowl in a couple of weeks.
Now I'd like to discuss our fourth quarter and full year performance for 2023 a year that played out very differently from what we were expecting. And I think the rest of you were expecting last year during a particularly challenging period for the banking industry. Umb delivered strong results, demonstrating the power and resilience of our diversified business model. We closed out the year with a solid fourth quarter I'll review a few highlights and then Ron will add more detail on the financial drivers section. As you know, most banks recognize expense for the FDIC's special assessment in the fourth quarter, our share of the assessment was $52.8 million, an impact of about $1.08 per share pretax to net income. We presented our financial metrics, both on a GAAP basis and adjusted to exclude this charge.
For the full year of 2023, net income was $350 million or $7.18 a share. On an adjusted basis, net operating income was $397.1 million or $8.14 per share for the fourth quarter we earned $70.9 million or $1.45 a share. However, as adjusted net operating income was $112 million or $2.29 per share, representing an increase of 13.9% compared to the third quarter of 2023 and 10.8% compared to the fourth quarter a year ago. Our results reflected strong loan growth and deposit growth, expanding net interest margin and net interest income, solid fee income growth and exceptional asset quality. Average loan balances increased 6.3% on an annualized basis from the third quarter to $23.1 billion for comparison banks between 10 and $100 billion in assets that have reported results so far have shown an annualized increase of 3.6%. We posted strong top line production 40% above third quarter and in line with our levels in recent quarters, construction and commercial real estate drove most of our loan growth in the fourth quarter with continued draws on previously approved construction loans. Payoff levels increased to 4.4% of loans impacting C&I balances. Cre growth has been largely in multifamily and industrial projects. Once again, we've included more detail on the portfolio in our slides, showing the mix of loans by type and geography, along with LTVs and other metrics. Asset quality in the book remains strong. We adhere to conservative standards, which includes underwriting to imputed or stressed interest rates and moderate loan to value ratios. We don't use trended rents and we have very strong liquid sponsors with great cash flow. 90% of our investment CRE portfolio is recourse. Speaking of asset quality. We reported excellent metrics with improvements across the board. Nonperforming loan levels improved again to six basis points, while delinquency levels declined. And we saw an 11% decrease in classified loans. Net charge-offs were two basis points of average loans for the quarter and just five basis points for the full year of 2023. Again, we outperformed peer banks, which have reported a median net charge-off rate for the fourth quarter of 15 basis points.
So far on slide 26, we included a longer term history of charge-offs, which have it averaged just 28 basis points over the last 20 years. In 2023, we experienced a 16 basis point reduction in our annual charge-off rate compared to 2022, reflecting the active management of our portfolio. I'm pleased with this result, especially given the environment and cautious narrative we're hearing across the industry. Again, we compare favorably to peer banks, which have reported a median six basis point increase in net charge-off levels year over year.
Moving to deposits, average balances increased 17.2% on an annualized basis from the third quarter. This growth was led by commercial customers, including 11% annualized increase in commercial DDA balances. We are seeing traction from our effort to bring clients total banking relationships to UMB, Pierre, so far have seen average annualized deposit growth of just 2.5% thus far in the quarter, net interest income increased 3.7% as margin improved three basis points sequentially from industry reports so far, our NIM expansion compares favorably with peers reporting a median decline of four basis points. We continue to deploy cash flows from the securities portfolio into loans and the pace of increased funding costs has slowed each of the past two quarters. Ron will share more detail on drivers on our margin outlook for 2024.
Noninterest income for the fourth quarter was $140.3 million, representing 38% of revenue, more than two times the 17% median reported by peers. Our fee businesses continue to build scale, and we're seeing momentum in several areas.
A few highlights include Fund Services, where assets under administration have eclipsed $411 billion, a $48 billion improvement over 2022 levels. And in our custody business, we have had a 27% increase in net new accounts this year. Our fixed income and trading teams saw increased activity as the expectation that the Fed has finished raising rates and has provided a little more clarity and brought some participants back into the market. We've shared additional detail on our fee income businesses and the revenue that provided by them in our slides. And Ron will add more detail when he speaks.
Total revenue for the fourth quarter increased 4.3% from a linked quarter basis. We posted positive operating leverage of 1.3% on a linked-quarter basis and 0.3% in the year-over-year quarter as seen on slide 31, our capital position improved during the fourth quarter with a 17-basis point increase in both CET1 and total capital ratios, which stood at 10.94% and 12.85%, respectively. Our earnings continue to support our capital position in spite of the impact of the FDIC special assessments.
Finally, we saw increased profitability ratios with operating ROTCE of 16.62% versus 14.96% in the third quarter. Tangible book value improved nearly 12% from September 30 to $58.12 per share. Peer banks so far have reported a median tangible book value increase of 6.9% linked quarter. Overall, we had a very solid quarter, especially given the challenging year we all had.
Before I turn it over to Ron, I'd like to share a few thoughts on the events of last spring that ultimately led to the FDIC special assessment we recognized in the fourth quarter. It has become very clear that the underlying cause of the 2023 bank failures was interest rate mismatch, primarily on the asset side, a few banks were ill position and poorly managed for the interest rate environment. We found ourselves in with a largely fixed asset base that lack flexibility, one lesson learned during that time was the power of various market participants to fuel a largely media-based crisis and circuits as the pandemic spread across media outlets, the risk of a self-fulfilling prophecy became real. Our reputation with our clients and in our markets is something we have earned and cherished over 100, 10 years of history. It was extremely frustrating for us to watch these industry observers pontificate based on a lack of understanding of how the industry works and continue to focus on the wrong symptoms like unadjusted uninsured deposits or ALCI. This was a classic case of facts getting in the way of a good narrative. As I said before, thank you to you, the analysts and the investors on the call with us today who took the time and care to understand the semantics of what transpired in the spring year-end reports have confirmed what we already knew to be true. The fundamentals in this industry remain steady. The demise of regional banks didn't happen as predicted. And banks like ours that were well prepared have not only weather the storm but emerge stronger and with positive results, the resiliency of the banking industry has been evident. And honestly, in recent months and the liquidity, regulatory capital levels, loan portfolio, asset quality and funding sources remained strong.
In closing, I'm incredibly proud of our UMB associates that drove this performance, and I'm deeply grateful to our loyal client base that grew with us through this much exaggerated industry noise in 2023. It was extremely rewarding to see how our company and customers came together to support each other. As always, we run our company with a strong focus on both the short term and the long term performance through every stage and every economic cycle. And we feel good about our strategy.
Looking ahead into 2024, we see a muted but resilient macro environment. And we remain well positioned for any environment with an attractive loan to deposit level, strong capital ratios and high-quality loan portfolio.
With that, I'll turn it over to Ram to give you more details on our results from.

Ram Shankar

Thanks, Mariner. Net interest income increased $8.2 million in the fourth quarter to $230.5 million, driven primarily by loan growth and repricing, along with higher levels of liquidity. Net interest margin was 2.46%, an increase of three basis points from the linked quarter, loan repricing and mix provided a nine basis point benefit. Other positives included three basis points from the benefit of free funds and liquidity levels, including stable levels of DDA balances, two basis points from the securities portfolio and one basis point from changes in borrowing levels. These benefits were partially offset by higher deposit costs cycle. To date, our earning asset beta has been tracking along with our total cost of funds beta both now at 53%. Average deposits increased 17.2% annualized from the third quarter benefiting from the ongoing deposit-gathering initiatives across all our lines of businesses. Typical seasonal increase in public fund balances during the month of December added $157 million in average deposits for the quarter. These increases were partially offset by the intentional reduction in brokered CD balances. Excluding those brokered deposits, average deposits increased 22% annualized from the prior quarter. Additionally, corporate trust deposits tend to be a little bit lumpy as clients build up cash and make payments throughout the year as the third largest municipal trustee in the U.S. balances will ebb and flow driven by municipal bond distributions and other activity. I'll note that on an end-of-period basis, corporate trust deposits increased pointing to the timing differences throughout the quarter in our escrow, specialty trust and paying agent businesses. Our deposit remix continued at a slower pace this quarter. Dda balances increased 1% from the third quarter and now represents 31% of total average deposits providing the benefit to margin. I noted cycle to date, betas on total deposits and on loan yields are 48% and 59%, respectively. This is on track with our previously discussed expectations for terminal betas of approximately 50% for deposit and 60% for loans.
Looking ahead into the first quarter, we expect our loan yields will continue to benefit from the flexibility we've built into our balance sheet through repricing as loans come up for renewal and from higher yields on new originations overall, we expect our loan yields to meet or exceed the increases in cost of funds. Additionally, we have approximately $1.6 billion in cash flows from our securities portfolio rolling off at 2.2% that will be reinvested in higher-yielding loans or securities. In the fourth quarter, we began legging back in with some modest repurchases of mortgage-backed and treasury securities. We will continue to assess based on collateral needs, loan growth and overall market conditions as liquidity and public fund balances seasonally dissipate. And given one less day in the first quarter, we expect net interest income and margin to compress modestly from Q4 levels. Actual performance will be driven by material shifts in funding mix, especially DDA balances and the shape of the curve details and activities in our securities portfolio are shown on slides 27 and 28. Combined AFS and held-to-maturity portfolios averaged $12.1 billion during the quarter. A decline of 1.5% from the third quarter. The average roll-off yield was 2.38% for the quarter. The new purchases of $154 million shown on the table excluded $500 million of short-term T-bills purchased at 5.39% as additional collateral or public funds deposits. Excluding those treasuries, we expect $1.6 billion of securities with a yield of two 23 to roll off over the next 12 months. The unrealized loss position in our combined securities book improved this quarter to $1.1 billion, representing approximately 8.5% of the total portfolio, down from 14% in the third quarter.
Back to the income statement, our provision expense of zero this quarter was the result of the impact of payoffs on net loan growth, the quality of our portfolio, including the low level of net charge-offs and macroeconomic variables that seem to expect a softer landing. As we look into the first quarter, we expect provision to be impacted by a small acquisition of a co-brand credit card portfolio expected to close in March, which will add approximately $125 million in balances with a day one provision of roughly $6 million, an ongoing provision based on portfolio performance growth and macroeconomic variables. This acquisition will also add approximately $10 million in net interest income, $2 million in interchange fees and a breakeven pretax pre-provision in the 1st year, excluding conversion and integration costs.
On the fee income side, reported results included some market related variances, including increases of $3.7 million in company-owned life insurance income and 567,000 in customer related derivative income training and investment banking income increased $2 million, primarily related to municipal trading volume. The detailed drivers of noninterest expense are shown in our slides and press release and on an GAAP basis included the recognition of the $52.8 million FDIC special assessment. On an operating basis, expenses increased $6.9 million or 3% from the third quarter to $235.9 million. Detailed variances are included on Slide 22 for the largest impacts were $3.1 million in deferred compensation expense, an increase of 2.7 million from the prior quarter. The offset to the increased call income $2.3 million related to the pre-buy of computers in the fourth quarter and $1.5 million in additional charitable contribution. Partial offsets included a $1.6 million decrease in payroll taxes, insurance and foreign one k. expense and a 467,000 reduction in bonus and commissions expense. Excluding the one-time items and timing-related variances, our core expense run rate in the fourth quarter was approximately $230 million. Please note that in addition to the impact of the co-brand card portfolio acquisition, first quarter salary and benefits expense will increase with the impact of the extra leap year day. And for the typical seasonal reset of PICA and payroll taxes, our effective tax rate was 17% for the full year 2023 compared to 18.9% in 2022. The decrease rate was driven primarily by a larger portion of income from tax-exempt securities and variations of the levels of quarterly income for 2024, we would expect a similar tax rate ranging from 17% to 19%.
That concludes our prepared remarks, and I'll now turn it back over to the operator to begin the Q&A portion of the call.

Question and Answer Session

Operator

(Operator Instructions)
Christopher McGratty, KBW.

Hi, this is Nick. I maybe just to start out on the margin, given the potential for rate cuts coming later in this year and '24, could we see the margin continue to expand into '24 with more back book repricing that continued mix shift?

Ram Shankar

I'm sure, Nick, this is wrong and we don't give any forward guidance other than what I said in my prepared comments about there might be some modest compression in the first quarter because of some of the excess liquidity that we saw in the fourth quarter going away. But as we said in the past calls, right, the higher for longer scenario is a good scenario for us because as you've seen in the last couple of quarters, the pressure on deposit costs have largely abated for us that our loan yields are still repricing higher. So loan yields will at least do better than cost of funds for us. And then that $1 billion of securities that are rolling off at 2.2% that we can invest in the current rate environment. So yes, I think we're close to the trough on margin in any particular quarter might have been for a little bit a few basis points here and there, but I feel good about our margin trajectory until the Fed starts cutting at some point in 20 for some of the nuance one way or the other area of strength was what happens to our demand deposits.

Mariner Kempre

Also, it hangs on the balance.

Great, thank you. And maybe could you also depend on the revenue outlook, I guess, a little bit, but could we see positive operating leverage in 2024 and depending on the expense growth?

Mariner Kempre

Well, I think the way we remain focused on on operating leverage. And again, based on the guidance question, we don't really give guidance, but I would say that the the environment that we come into 2024 with from 2023 remains from a standpoint of elevated interest expense and the interest rate environment. And because of that, you know, demonstrating you dilute strengths on on the operating leverage remains challenging. We'll continue to do everything we can and work against it. We believe on a relative basis that will outperform on on operating leverage.

Great. Thank you for taking my question.

Ram Shankar

Thanks, Nick.

Operator

(Operator Instructions)
Nathan Race, Piper Sandler.

Nathan Race

Hey, guys, good morning and congrats on a nice win. Some I've just a question on the NII sensitivity I appreciate the disclosure in the deck around, you know, 100 basis point decline in rates is about a 3.1% impact to NII in year two. Just curious though, to what extent you think that it can be offset by just the volume of your kind of continued margin accretive growth in both loans and deposits going forward? And also with the cash flow you have coming off the securities portfolio as well?

Ram Shankar

Yes, you hit the nail on the head there, Nate.
That is a static analysis. As you know, right, so it's all based on just cash flows coming in and being reinvested in a new environment. And so the net interest income projected in that baseline scenario of minus 100 in year two does not include the impact of any growth in any actions we might take, right? You've seen us and you'll see in our disclosures that we put on. So far Sloss synthetic hedges as well. So we'll do additional we'll evaluate it on a periodic basis and put on additional hedges to protect ourselves from a down rate environment. But that's just a statistical modeling of what would happen to our balance sheet if all things were kept the same on a static balance sheet basis. So we can take steps to mitigate it. And so that's another layer that will add onto it.

Mariner Kempre

And as you think about looking forward into 24, we typically give you a 90 day look forward loan growth and the first quarter, it looks stronger than it did in the fourth quarter. So Oscient continue to be good.

Nathan Race

Okay, great. And then just within that context around kind of the trajectory part of the call, did you guys have about $2.5 billion in wholesale funding maturing in the first half of this year? How are you guys thinking about replacing that as the cash flow securities book going to be one lever? And then any other kind of thoughts on just how we should think about those wholesale sources in the first half?

Ram Shankar

Yes, Page 31 is yes, on page 31 on the bottom right, we have all the wholesale funding. Obviously, as you can see, we have about $1.6 billion of brokered CDs. Given our deposit pipeline, which remains strong, we might not need all of it.

Mariner Kempre

Right? So but the potential the way what market rates are at that point and we have made ligand for half of it or something less than that. And the other one other maturing that will mature in the second quarter to $1 billion plus of advances. And then we have BTSP., which will extend into January. Again, we'll evaluate it based on collateral needs, will base it on where market rates are. We'll look for spread and all those things, but we don't need any of those tools really given our liquidity position and our loan to deposit.
But we'll take it as the environment evolves, the Asic, the Ron's comment about the brokered CDs. We may we don't need them, but we may roll back into some of them just because by the time they come due rates will likely have come down and we can have positive arbitrage on them. So might make sense to roll back into some of them just from a profitability standpoint.

Nathan Race

Okay. Got it. Very helpful. Maybe just turning to credit, I'm curious to hear perhaps from Tom, in terms of what occurred in the quarter in terms of criticized classified trends and obviously, charge-offs have been very low over the last few quarters. And I think in the past, we've talked about a normalized charge-off range in the 20 to 30 of range. So just curious just given where MBA band and based on the commentary around criticized trends, if you think we're going to get back to the historical range at some point this year or into 2025?

Ram Shankar

You know, that's my favorite question because it's the thing that we're really most proud of. And I think that when you think I think about this investor community and looking at your alternatives and the investment thesis looking into banks, the thing that you look at with us is I'm sitting at the table right here with I've two other guys that have been making credit decisions with me for 20 years through all of the cycles that we've looked at and we've outperformed the peer group in all of those cycles. And when we talk about 27, 28 basis points, we're just using math history. If you look at page 26, you're just you're just looking at our history. And one thing I would note about that in our investment deck is while yes, the average over 20 years is higher than the two basis points we have in fourth quarter, you have to recognize that comes with a lot of growth. So if you go back 20 years ago, the 1st year, I would see we had $2.7 billion in loans with 20 basis points of charge-off. Today, we have $23 billion in loans with two basis points of charge-offs. So in the context of a much greater opportunity for loss. We've maintained a very, very low charge-off rate, and that's because of kind of consistency and continuity of approach. And you know, we make this easy for you guys because you can look at the history, you know, most of the banks who looked at have different teams and turnover and change in strategy, change and acquisitions wherever it is, you're staring at the same company with the same team, the same results and what I would say about the 28, when you think about this year, where wherever we end up we will outperform. And what I would say, if you look at the charge-off history over the last 20 years, us against the peer, we had a chart the second page before that shows that it's in a different percentage, though, we haven't really a chart that shows us against a peer group. And if you see the point is if you look at a recessionary period. Our line, our Delta line stays very close to the bottom axis of the chart. Well, there's a shark fin that takes place with the industry. So and that's what happened in the last crisis. We expect that to happen. If you look at it through the fourth quarter, as are, you can see it already taking place. Our numbers don't move and the peer groups and the industry starting to move up. We expect that to be the case, again, whatever the absolute numbers are, I can't tell you, but the relationship to the peer group and the industry, we expect to remain same.

Nathan Race

Okay, great. Very helpful. And just one last one on. It seemed like a lot of the growth in the quarter came on the commercial real estate side of things. So just curious in terms of the composition of that pipeline entering 2024 and kind of where you guys are seeing a pretty pronounced opportunities to grow loans today, you know, loan growth.

Ram Shankar

We've been saying this for a really, really long time. We call it out. We have a long runway for growth on both geographically and vertically across our footprint, international footprint related to our ABL business, largely because of market share gains. And we expect that to remain the same The caveat to that would be if we do have a softening in a softening economy, the rate at which we would grow on an absolute basis may come down from what our expectations are for ourselves. But on a relative basis, we would expect ourselves to continue to outperform on loan growth. For the same reasons we always have for 20 years, we've done that and we expect that to continue again for the same very same reasons, which would be more market share, more or more market share driven. And then they are economic conditions driven. So nothing new there on the absolute number could come down a bit from what we did last year based on what economic conditions are. But again, you're buying on a relative basis, we content we expect ourselves to outperform on a relative basis.

Mariner Kempre

Again, Mark market-specific, it's still coming from the major metros. Utah has been a nice growth market for us. Where we have loan production offices and that seems to continue to build. But we are seeing a strong traditional operating companies.
See.

Kay Gregory

And I'll let Mary said, it's market share driven and first quarter, as I said, look stronger than Q3 or if that's any indication.

Mariner Kempre

Right.

Kay Gregory

We have a hard time themselves looking beyond the first quarter with both the first quarters it first quarter is an indication of the rest of the year, stronger than Q4, but nonetheless.
Okay, understood. Very helpful. And if I could just ask one last one on good theory change in credit rating credit ratings across, I think around 4% of loans that are tied to office CRE.
I'm not sure I understand the credit rating question. What do you now in that risk-rating?
Excuse me, Mariner.
So Christina, we will now make racing often specified risk-rating excuse me follow it.
So that yes, we've had very little of any deterioration in our office portfolio, it's remained strong at 4.5% of the portfolio. As you said, a couple of statistics, 45% of our office portfolio was single tenant which adds a layer of strength there.
In terms of rollover strong sponsors, which we've talked about in the past, we have seen basically no deterioration in that portfolio and don't really see anything coming on the horizon there, performing a lot of the leases, the underlying leases on these offers, our projects go out to 27 and beyond, roughly 70% of those leases are 27 and beyond.
So in terms of rollover in the short term, very manageable.
Okay, perfect. I appreciate the color.

Ram Shankar

Thank you.
Thanks, Adrian.

Kay Gregory

Yes, thanks, everybody. It looks like that's the last question.
Just want to reiterate something. You know, we're really proud of the year we had in the quarter and I think at the end of the day, we do what we say and we say what we do, and we've been doing it for a long time. And we've demonstrated strong outsized loan growth, deposit growth fees, expense control a year in and year out. And I think the good news for the investor population as they think about us is you should know what to expect from us now and we did it again in the fourth quarter. And we're it's more thrilled than ever about the fourth quarter because we were able to sort of, you know, put to bed a lot of the nonsense in the narrative, as I like to say know, don't let basket in a way, have a real exciting narrative that the pundits like to deliver last year. And so on behalf of everybody on the call, we're happy to have delivered on what we did in the fourth quarter to kind of put some of that nonsense to bet. And so we'll just keep doing it for you and where we're really proud and excited about what we delivered. And we're just going to keep doing it for you. So thanks.

Operator

Thanks, Mariner. And if anyone has follow-up economically to reach us at eight one six eight six zero seven one zero six, and we appreciate your time. Thanks for joining us.
Today concludes today's call and thank you for joining. You may now disconnect.

Kay Gregory

No.